Statement of Financial Accounting Standards No. 95

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1 Statement of Financial Accounting Standards No. 95 FAS95 Status Page FAS95 Summary Statement of Cash Flows November 1987 Financial Accounting Standards Board of the Financial Accounting Foundation 401 MERRITT 7, P.O. BOX 5116, NORWALK, CONNECTICUT

2 Copyright 1987 by Financial Accounting Standards Board. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Standards Board. Page 2

3 Statement of Financial Accounting Standards No. 95 Statement of Cash Flows November 1987 CONTENTS Paragraph Numbers Introduction Standards of Financial Accounting and Reporting: Scope...3 Purpose of a Statement of Cash Flows Focus on Cash and Cash Equivalents Gross and Net Cash Flows Classification of Cash Receipts and Cash Payments Cash Flows from Investing Activities Cash Flows from Financing Activities Cash Flows from Operating Activities Foreign Currency Cash Flows...25 Content and Form of the Statement of Cash Flows Information about Noncash Investing and Financing Activities...32 Cash Flow per Share...33 Effective Date and Transition...34 Appendix A: Background Information Appendix B: Basis for Conclusions Appendix C: Illustrative Examples Appendix D: Amendments to Existing Pronouncements Page 3

4 FAS 95: Statement of Cash Flows FAS 95 Summary This Statement establishes standards for cash flow reporting. It supersedes APB Opinion No. 19, Reporting Changes in Financial Position, and requires a statement of cash flows as part of a full set of financial statements for all business enterprises in place of a statement of changes in financial position. This Statement requires that a statement of cash flows classify cash receipts and payments according to whether they stem from operating, investing, or financing activities and provides definitions of each category. This Statement encourages enterprises to report cash flows from operating activities directly by showing major classes of operating cash receipts and payments (the direct method). Enterprises that choose not to show operating cash receipts and payments are required to report the same amount of net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities (the indirect or reconciliation method) by removing the effects of (a) all deferrals of past operating cash receipts and payments and all accruals of expected future operating cash receipts and payments and (b) all items that are included in net income that do not affect operating cash receipts and payments. If the direct method is used, a reconciliation of net income and net cash flow from operating activities is required to be provided in a separate schedule. This Statement requires that a statement of cash flows report the reporting currency equivalent of foreign currency cash flows, using the current exchange rate at the time of the cash flows. The effect of exchange rate changes on cash held in foreign currencies is reported as a separate item in the reconciliation of beginning and ending balances of cash and cash equivalents. This Statement requires that information about investing and financing activities not resulting in cash receipts or payments in the period be provided separately. This Statement is effective for annual financial statements for fiscal years ending after July 15, Restatement of financial statements for earlier years provided for comparative purposes is encouraged but not required. Page 4

5 INTRODUCTION 1. This Statement establishes standards for providing a statement of cash flows in general-purpose financial statements. This Statement supersedes APB Opinion No. 19, Reporting Changes in Financial Position, and requires a business enterprise to provide a statement of cash flows in place of a statement of changes in financial position. It also requires that specified information about noncash investing and financing transactions and other events be provided separately. 2. Opinion 19 permitted but did not require enterprises to report cash flow information in the statement of changes in financial position. Since that Opinion was issued, the significance of information about an enterprise's cash flows has increasingly been recognized. In FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, paragraph 13, the Board says, "A full set of financial statements for a period should show:... Cash flows during the period." Moreover, certain problems have been identified in current practice, including the ambiguity of terms such as funds, lack of comparability arising from diversity in the focus of the statement (cash, cash and short-term investments, quick assets, or working capital) and the resulting differences in definitions of funds flows from operating activities (cash or working capital), differences in the format of the statement (sources and uses format or activity format), variations in classifications of specific items in an activity format, and the reporting of net changes in amounts of assets and liabilities rather than gross inflows and outflows. The lack of clear objectives for the statement of changes in financial position has been suggested as a major cause of that diversity. STANDARDS OF FINANCIAL ACCOUNTING AND REPORTING Scope 3. A business enterprise that provides a set of financial statements that reports both financial position and results of operations shall also provide a statement of cash flows for each period for which results of operations are provided. This Statement supersedes or amends the accounting pronouncements listed in Appendix D. Purpose of a Statement of Cash Flows 4. The primary purpose of a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an enterprise during a period. Page 5

6 5. The information provided in a statement of cash flows, if used with related disclosures and information in the other financial statements, should help investors, creditors, and others to (a)assess the enterprise's ability to generate positive future net cash flows; (b) assess the enterprise's ability to meet its obligations, its ability to pay dividends, and its needs for external financing; (c) assess the reasons for differences between net income and associated cash receipts and payments; and (d) assess the effects on an enterprise's financial position of both its cash and noncash investing and financing transactions during the period. 6. To achieve its purpose of providing information to help investors, creditors, and others in making those assessments, a statement of cash flows should report the cash effects during a period of an enterprise's operations, its investing transactions, and its financing transactions. Related disclosures should report the effects of investing and financing transactions that affect an enterprise's financial position but do not directly affect cash flows during the period. A reconciliation of net income and net cash flow from operating activities, which generally provides information about the net effects of operating transactions and other events that affect net income and operating cash flows in different periods, also should be provided. Focus on Cash and Cash Equivalents 7. A statement of cash flows shall explain the change during the period in cash 1 and cash equivalents. The statement shall use descriptive terms such as cash or cash and cash equivalents rather than ambiguous terms such as funds. The total amounts of cash and cash equivalents at the beginning and end of the period shown in the statement of cash flows shall be the same amounts as similarly titled line items or subtotals shown in the statements of financial position as of those dates. 8. For purposes of this Statement, cash equivalents are short-term, highly liquid investments that are both: a. Readily convertible to known amounts of cash b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities 2 of three months or less qualify under that definition. 9. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an enterprise with banking operations). Cash purchases and sales of those investments generally are part of the enterprise's cash management activities rather than part of its operating, investing, and financing activities, and details of those transactions need not be reported in a statement of cash flows. 10. Not all investments that qualify are required to be treated as cash equivalents. An Page 6

7 enterprise shall establish a policy concerning which short-term, highly liquid investments that satisfy the definition in paragraph 8 are treated as cash equivalents. For example, an enterprise having banking operations might decide that all investments that qualify except for those purchased for its trading account will be treated as cash equivalents, while an enterprise whose operations consist largely of investing in short-term, highly liquid investments might decide that all those items will be treated as investments rather than cash equivalents. An enterprise shall disclose its policy for determining which items are treated as cash equivalents. Any change to that policy is a change in accounting principle that shall be effected by restating financial statements for earlier years presented for comparative purposes. Gross and Net Cash Flows 11. Generally, information about the gross amounts of cash receipts and cash payments during a period is more relevant than information about the net amounts of cash receipts and payments. However, the net amount of related receipts and payments provides sufficient information not only for cash equivalents, as noted in paragraph 9, but also for certain other classes of cash flows specified in paragraphs 12, 13, and For certain items, the turnover is quick, the amounts are large, and the maturities are short. For certain other items, such as demand deposits of a bank and customer accounts payable of a broker-dealer, the enterprise is substantively holding or disbursing cash on behalf of its customers. Only the net changes during the period in assets and liabilities with those characteristics need be reported because knowledge of the gross cash receipts and payments related to them may not be necessary to understand the enterprise's operating, investing, and financing activities. 13. Items that qualify for net reporting because their turnover is quick, their amounts are large, and their maturities are short are cash receipts and payments pertaining to (a) investments (other than cash equivalents), (b) loans receivable, and (c) debt, providing that the original maturity of the asset or liability is three months or less. 3 Classification of Cash Receipts and Cash Payments 14. A statement of cash flows shall classify cash receipts and cash payments as resulting from investing, financing, or operating activities. 4 Cash Flows from Investing Activities 15. Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the enterprise (other than materials that are part of the enterprise's inventory). Page 7

8 16. Cash inflows from investing activities are: 5 a. Receipts from collections or sales of loans made by the enterprise and of other entities' debt instruments (other than cash equivalents) that were purchased by the enterprise b. Receipts from sales of equity instruments of other enterprises and from returns of investment in those instruments c. Receipts from sales of property, plant, and equipment and other productive assets. 17. Cash outflows for investing activities are: a. Disbursements for loans made by the enterprise and payments to acquire debt instruments of other entities (other than cash equivalents) b. Payments to acquire equity instruments of other enterprises c. Payments at the time of purchase or soon before or after purchase 6 to acquire property, plant, and equipment and other productive assets. 7 Cash Flows from Financing Activities 18. Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit. 19. Cash inflows from financing activities are: a. Proceeds from issuing equity instruments b. Proceeds from issuing bonds, mortgages, notes, and from other short- or long-term borrowing. 20. Cash outflows for financing activities are: a. Payments of dividends or other distributions to owners, including outlays to reacquire the enterprise's equity instruments b. Repayments of amounts borrowed c. Other principal payments to creditors who have extended long-term credit. 8 Cash Flows from Operating Activities 21. Operating activities include all transactions and other events that are not defined as investing or financing activities in paragraphs Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net Page 8

9 income. 22. Cash inflows from operating activities are: a. Cash receipts from sales of goods or services, including receipts from collection or sale of accounts and both short- and long-term notes receivable from customers arising from those sales b. Cash receipts from returns on loans, other debt instruments of other entities, and equity securities interest and dividends c. All other cash receipts that do not stem from transactions defined as investing or financing activities, such as amounts received to settle lawsuits; proceeds of insurance settlements except for those that are directly related to investing or financing activities, such as from destruction of a building; and refunds from suppliers. 23. Cash outflows for operating activities are: a. Cash payments to acquire materials for manufacture or goods for resale, including principal payments on accounts and both short- and long-term notes payable to suppliers for those materials or goods b. Cash payments to other suppliers and employees for other goods or services c. Cash payments to governments for taxes, duties, fines, and other fees or penalties d. Cash payments to lenders and other creditors for interest e. All other cash payments that do not stem from transactions defined as investing or financing activities, such as payments to settle lawsuits, cash contributions to charities, and cash refunds to customers. 24. Certain cash receipts and payments may have aspects of more than one class of cash flows. For example, a cash payment may pertain to an item that could be considered either inventory or a productive asset. If so, the appropriate classification shall depend on the activity that is likely to be the predominant source of cash flows for the item. For example, the acquisition and sale of equipment to be used by the enterprise or rented to others generally are investing activities. However, equipment sometimes is acquired or produced to be used by the enterprise or rented to others for a short period and then sold. In those circumstances, the acquisition or production and subsequent sale of those assets shall be considered operating activities. Foreign Currency Cash Flows 25. A statement of cash flows of an enterprise with foreign currency transactions or foreign operations shall report the reporting currency equivalent of foreign currency cash flows using the exchange rates in effect at the time of the cash flows. An appropriately weighted average exchange rate for the period may be used for translation if the result is substantially the same as if the rates at the dates of the cash flows were used. 9 The statement shall report the effect of Page 9

10 exchange rate changes on cash balances held in foreign currencies as a separate part of the reconciliation of the change in cash and cash equivalents during the period. Content and Form of the Statement of Cash Flows 26. A statement of cash flows for a period shall report net cash provided or used by operating, investing, and financing activities 10 and the net effect of those flows on cash and cash equivalents during the period in a manner that reconciles beginning and ending cash and cash equivalents. 27. In reporting cash flows from operating activities, enterprises are encouraged to report major classes of gross cash receipts and gross cash payments and their arithmetic sum the net cash flow from operating activities (the direct method). Enterprises that do so should, at a minimum, separately report the following classes of operating cash receipts and payments: 11 a. Cash collected from customers, including lessees, licensees, and the like b. Interest and dividends received c. Other operating cash receipts, if any d. Cash paid to employees and other suppliers of goods or services, including suppliers of insurance, advertising, and the like e. Interest paid f. Income taxes paid g. Other operating cash payments, if any. Enterprises are encouraged to provide further breakdowns of operating cash receipts and payments that they consider meaningful and feasible. For example, a retailer or manufacturer might decide to further divide cash paid to employees and suppliers (category (d) above) into payments for costs of inventory and payments for selling, general, and administrative expenses. 28. Enterprises that choose not to provide information about major classes of operating cash receipts and payments by the direct method as encouraged in paragraph 27 shall determine and report the same amount for net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities (the indirect or reconciliation method). That requires adjusting net income to remove (a) the effects of all deferrals of past operating cash receipts and payments, such as changes during the period in inventory, deferred income, and the like, and all accruals of expected future operating cash receipts and payments, such as changes during the period in receivables and payables, 12 and (b) the effects of all items whose cash effects are investing or financing cash flows, such as depreciation, amortization of goodwill, and gains or losses on sales of property, plant, and equipment and discontinued operations (which relate to investing activities), and gains or losses on extinguishment of debt (which is a financing activity). Page 10

11 29. The reconciliation of net income to net cash flow from operating activities described in paragraph 28 shall be provided regardless of whether the direct or indirect method of reporting net cash flow from operating activities is used. That reconciliation shall separately report all major classes of reconciling items. For example, major classes of deferrals of past operating cash receipts and payments and accruals of expected future operating cash receipts and payments, including at a minimum changes during the period in receivables pertaining to operating activities, in inventory, and in payables pertaining to operating activities, shall be separately reported. Enterprises are encouraged to provide further breakdowns of those categories that they consider meaningful. For example, changes in receivables from customers for an enterprise's sale of goods or services might be reported separately from changes in other operating receivables. In addition, if the indirect method is used, amounts of interest paid (net of amounts capitalized) and income taxes paid during the period shall be provided in related disclosures. 30. If the direct method of reporting net cash flow from operating activities is used, the reconciliation of net income to net cash flow from operating activities shall be provided in a separate schedule. If the indirect method is used, the reconciliation may be either reported within the statement of cash flows or provided in a separate schedule, with the statement of cash flows reporting only the net cash flow from operating activities. If the reconciliation is presented in the statement of cash flows, all adjustments to net income to determine net cash flow from operating activities shall be clearly identified as reconciling items. 31. Except for items described in paragraphs 12 and 13, both investing cash inflows and outflows and financing cash inflows and outflows shall be reported separately in a statement of cash flows for example, outlays for acquisitions of property, plant, and equipment shall be reported separately from proceeds from sales of property, plant, and equipment; proceeds of borrowings shall be reported separately from repayments of debt; and proceeds from issuing stock shall be reported separately from outlays to reacquire the enterprise's stock. Information about Noncash Investing and Financing Activities 32. Information about all investing and financing activities of an enterprise during a period that affect recognized assets or liabilities but that do not result in cash receipts or cash payments in the period shall be reported in related disclosures. Those disclosures may be either narrative or summarized in a schedule, and they shall clearly relate the cash and noncash aspects of transactions involving similar items. Examples of noncash investing and financing transactions are converting debt to equity; acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining an asset by entering into a capital lease; and exchanging noncash assets or liabilities for other noncash assets or liabilities. Some transactions are part cash and part noncash; only the cash portion shall be reported in the statement of cash flows. Page 11

12 Cash Flow per Share 33. Financial statements shall not report an amount of cash flow per share. Neither cash flow nor any component of it is an alternative to net income as an indicator of an enterprise's performance, as reporting per share amounts might imply. Effective Date and Transition 34. The provisions of this Statement shall be effective for annual financial statements for fiscal years ending after July 15, Earlier application is encouraged. This Statement need not be applied in financial statements for interim periods in the initial year of application, but cash flow information for those interim periods shall be restated if reported with annual financial statements for that fiscal year. Restatement of comparative annual financial statements for earlier years is encouraged but not required. The provisions of this Statement need not be applied to immaterial items. This Statement was adopted by the affirmative votes of four members of the Financial Accounting Standards Board. Messrs. Lauver, Leisenring, and Swieringa dissented. Messrs. Lauver, Leisenring, and Swieringa dissent to this Statement's requirements to classify interest and dividends received and interest paid as cash flows from operating activities. They believe that interest and dividends received are returns on investments in debt and equity securities that should be classified as cash inflows from investing activities. They believe that interest paid is a cost of obtaining financial resources that should be classified as a cash outflow for financing activities. Messrs. Lauver, Leisenring, and Swieringa also dissent to this Statement's requirement to classify certain cash receipts and payments according to the nature of an earlier transaction rather than according to the nature of the cash receipts and payments. Under this Statement, an enterprise that sells merchandise in one year for an installment note receivable and receives principal payments on the note in subsequent years will classify those principal payments as operating cash inflows. They believe that those principal payments should be classified as cash inflows from investing activities because they represent a return of the enterprise's investment in the installment note. Classifying those principal payments as operating cash inflows denies receipt of the installment note as a noncash investing activity, is inconsistent with the enterprise's recovery of its investment in that note, and is inconsistent with the treatment of the receipt of principal payments on other investments in debt instruments as cash inflows from investing activities. They also note that this Statement will result in similar inconsistencies for the purchase of inventory in exchange for a note payable. Messrs. Lauver and Swieringa also dissent to this Statement's permitted use of the Page 12

13 indirect method of reporting net cash flow from operating activities. They believe that by permitting the continued use of the indirect method, the Board has foregone the opportunity to make a significant contribution to the quality of financial reporting and to enhanced user understanding of cash flows from operating activities. Reporting information about cash received from customers, cash paid to suppliers and employees, income taxes paid, and other operating receipts and payments (the direct method) provides a description of the operating activities of an entity during a period that is both more informative and more consistent with the primary purpose of a statement of cash flows, which is described in paragraph 4 of this Statement as "to provide relevant information about the cash receipts and cash payments of an enterprise during a period." Because the indirect method does not result in reporting separately major classes of gross operating cash flows, Messrs. Lauver and Swieringa believe that method is inconsistent with the conclusion in paragraph 11 that " generally, information about gross amounts of cash receipts and cash payments during a period is more relevant than information about the net amounts of cash receipts and payments." Further, permitting use of the indirect method makes this Statement internally inconsistent because major classes of gross cash flows from investing and financing activities are required to be reported separately while major classes of gross operating cash flows are not. In addition, presenting a reconciliation of net income and net cash flow from operating activities within the statement of cash flows rather than in a separate schedule results in including the effects of certain noncash transactions and other events within the statement of cash flows. Messrs. Lauver and Swieringa believe that is confusing and counter to the primary purpose of a statement of cash flows. Mr. Lauver believes the internal inconsistencies in the provisions of this Statement concerning the classification of cash flows identified in the preceding paragraphs result from putting other objectives ahead of the Statement's stated objective of providing relevant information about cash receipts and payments. He believes that by adopting the view that the cash effects of transactions and events that enter into the determination of net income are cash flows from operating activities (paragraph 21), this Statement, in spite of comments to the contrary (paragraph 33), attempts to establish net cash from operating activities as an alternative performance indicator, an objective that he believes is undesirable. Further, that objective makes each of the three categories misleading by excluding from investing and financing categories cash receipts and payments that stem from investing and financing activities and ought to be included in those categories. The result is that none of the three required categories of cash flows is aptly named and all of them are, therefore, likely to be misunderstood. Mr. Lauver observes that a statement of cash flows involves no issues of recognition, measurement, or estimation; by definition it includes only the effects of identifiable, unquestioned transactions. In that circumstance, the financial reporting function involves only two tasks. The first is to aggregate similar cash receipts and payments to facilitate communication and understanding and to do so consistently. The second is to accurately characterize the various aggregations so that they are unlikely to be misunderstood. He believes this Statement fails to do either. Page 13

14 Members of the Financial Accounting Standards Board: Dennis R. Beresford, Chairman Victor H. Brown Raymond C. Lauver James J. Leisenring David Mosso C. Arthur Northrop Robert J. Swieringa Appendix A: BACKGROUND INFORMATION 35. As part of its work on the conceptual framework, the FASB issued a Discussion Memorandum in December 1980, Reporting Funds Flows, Liquidity, and Financial Flexibility, which discussed funds flow reporting issues. Major issues raised in the Discussion Memorandum relating to funds flow reporting included (a) the concept of funds that should be adopted as the focus of the funds flow statement, (b) the reporting of transactions that have no direct impact on funds, (c) the approaches for presenting information about funds flows, (d) the presentation of information about funds flows from operations, (e) the separation of funds flow information about investing activities into outflows for maintenance of operating capacity, expansion of operating capacity, or nonoperating purposes, and (f) summary indicators of funds flows. The Board received 190 letters of comment in response to the Discussion Memorandum. In May 1981, a public hearing was held to discuss the issues raised in the Discussion Memorandum. Thirty-two individuals and organizations appeared at the hearing. 36. In November 1981, the Board issued an Exposure Draft of a proposed concepts Statement, Reporting Income, Cash Flows, and Financial Position of Business Enterprises. That Exposure Draft discussed the role of a funds statement and guides for reporting components of funds flows, concluding that funds flow reporting should focus on cash rather than on working capital. One hundred twenty-six comment letters were received in response to the November 1981 Exposure Draft. After considering those comment letters, the Board decided not to issue a final Statement on that subject. Instead, the Board chose to consider the subject in connection with its study of recognition and measurement concepts. In December 1983, the Board issued another Exposure Draft of a concepts Statement, Recognition and Measurement in Financial Statements of Business Enterprises, which also discussed the role of the cash flow statement. One hundred four comment letters were received on that Exposure Draft. In December 1984, the Board issued FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, which includes general guidance on a statement of cash flows and concludes that, in concept, a cash flow statement should be part of a full set of financial statements. Page 14

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